Someone else’s problem? The IFRS enforcement field in Europe

Abstract

This study adopts an institutional lens to explore enforcement as a complex and nuanced phenomenon shaped by the dynamics of its social context. It examines an IFRS regulatory incident that fails to conclude with any decision or resolving action in the context of the European Union, and as such invites serious questioning of enforcement functions. From our analysis accounting enforcement emerges as an interacting issue-based field in which auditors and the national enforcement agency adhere narrowly to their tasks, ensuring formal but not substantive IFRS compliance. Field participants are seen to respond to institutional pressures strategically by avoiding public positions and delegating choices to other actors, substantially accepting earnings manipulation. Our study shows that the national enforcer increased its interactions with other regulatory actors (i.e. agencies concerned with the setting and interpretation of standards) in the case of controversial issues and their responses can heavily influence overall enforcement effectiveness. Furthermore, its findings contribute to debates on the need for a pan-European enforcement agency and shed light on the importance of IFRS interpretation for the enforceability of international accounting standards.

Keywords:

• financial accounting
• case study
• IFRS enforcement
• issue-based field
• standard interpretation
• strategic responses

JEL classifications:

• M41
• M48
• E58
• G21

Acknowledgements

The authors gratefully acknowledge input and constructive support from the editorial and review process at Accounting and Business Research. They are also grateful for the comments and suggestions on earlier drafts from the participants at the EIASM Workshop on Preventing Accounting Scandals in Monaco (March 2019), the Financial Reporting and Business Communication Conference in Durham (July 2017), the EUFIN workshop in Fribourg (September 2016), the EIASM Workshop on Accounting and Regulation in Siena (July 2016), and the EAA Annual Congress in Maastricht (May 2016).

Disclosure statement

No potential conflict of interest was reported by the authors.

Notes

1 Namely, the Securities and Exchange Commission’s Accounting and Auditing Enforcement Releases.

2 Following Boxenbaum and Jonsson (2017), we do not use the term ‘decoupling’, which some empirical studies interpret extensively, especially regarding the organisational structure.

3 On 31 May, the Economy Minister stressed this point in a meeting with ABI’s key personalities and the Chief Operating Officer of a major bank to discuss banks’ conditions and evaluate how to support them in granting credit to the economy.

4 Under the Single Supervisory Mechanism framework, the ECB directly supervises 118 major European banks in the scope of the Supervisory Review and Evaluation Process and delegates the supervision of other banks to national competent authorities. Under this regime, 12 major Italian banks passed from BI’s national supervision to the direct surveillance of the ECB in 2014. BI actively assists European institutions in their supervisory tasks and carries out macro-prudential supervision. In particular, it cooperates with the ECB in the asset quality review to detect whether banks hold overvalued assets on their balance sheets and performs (biannual) stress tests together with the European Banking Authority to verify the resilience of balance sheets to shocks.

5 BI originated in 1893 from the merger of three issuing banks (Banca Nazionale del Regno d’Italia, Banca Nazionale Toscana, and Banca Toscana di Credito). The 1936 Banking Law defined BI as a public law organisation charged with monetary policy and the supervision of the banking system under the direction of the government.

6 BI shareholders appoint directors who have no competence in matters of financial supervision, while BI’s governor is appointed by the President of the Republic on the proposal of the government. Furthermore, BI is subject to the independence requirements of the ECB Statute (Article 7), which provides that national central banks shall not seek or take instructions from when exercising the powers and carrying out the tasks and duties conferred upon them by the Treaties and the ECB Statute.

7 At the end of 2013, BI’s shares were owned by fifty two Italian banks (84.488% of the shares), a bank based in San Marino (0.012% of the shares), five insurance companies (9.8%), and the Italian Social Security Agency and Italian Workers Compensation Authority (a combined 5.7%).

8 The government’s hurry was a considerable disappointment for the ECB, which stated that ‘the adoption of legislative provisions prior to delivery of the opinion or expiry of the set deadline is tantamount to a non-consultation of the ECB’ (ECB 2013b, p. 4). Despite such a disappointment, the ECB did not take any specific measure on the matter.

9 These new shares, which could be sold either to European entities or to BI itself, granted shareholders the rights derived from the revised bylaw, which included two main amendments: (i) a dividend threshold of 6% of the (newly increased) capital per year, without any distribution of reserves, and (ii) an individual holding limit of 3%, with exclusion from dividend rights for exceeding shares after three years.

10 The only exception was Bank D, which classified shares as equity investments in associates. However, the bank evaluated BI shares at cost – instead of using the equity method under IAS 28 – because of the lack of a significant influence on BI, whose Statute ensures independence from shareholders. In other words, this classification did not affect shares’ measurement basis.

11 Banks explained that using nominal value or historical cost as the measurement basis derived from the lack of a market for BI shares. Therefore, carrying values were nominal values or resulted from M&A operations involving BI shareholders.

12 To determine the impact of the manipulation under analysis, we consider all unconsolidated and consolidated IFRS reports publicly available. More specifically, we analyse the 2013 unconsolidated annual reports of 42 banks, excluding ten unconsolidated reports unavailable. Overall, these 10 banks held 1.458% of BI’s share capital at the end of 2013. However, the individual effects of four of these banks are cumulatively presented in the consolidated annual reports. Additionally, we examine all available 2013 consolidated annual reports (19 reports).

13 The considerable change in assets, equal to 5 billion euro for the 41 banks considered, made European regulators fear the possibility of bias in forthcoming European stress tests. However, banks neutralised the effect on their regulatory capital through a negative prudential filter (or adjustment) in 2013 which served to exclude the revaluation amount from the regulatory capital calculation required by financial regulators (i.e., ECB and European Banking Authority). As a consequence, the revaluation amount did not give any benefits to the banks in terms of capital adequacy for 2013. It did, however, in 2014, because banks did not neutralise this effect, as demonstrated in their financial statements.

14 Bank A in Appendix 2.

15 In more detail, these professional opinions concerned the legal and accounting consequences of BI’s capital revaluation. The first opinion was from an expert in the juridical field; this report underlined that the rights incorporated in the original shares had expired. From his perspective, different rights embedded in the new shares would have replaced the previous ones. An expert of established reputation both in the academic and in the professional accounting community provided a second opinion. Drawing on legal opinion, he did not support the regular treatment for AFS fair value gains and depicted the revaluation as an exchange of shares, requiring the derecognition of the ‘old’ BI shares (IAS 39, paragraph 17) and thus opening the door for the recognition of the fair value gain in the P&L.

16 Our analysis focused on forty two auditor reports due to ten unavailable reports (see Table 1).

17 This is not the normal procedure for the enforcement of annual reports, which is ex-post enforcement; however, such ex-ante enforcement decisions (including preclearance) are not precluded under the European system (The Committee of European Securities Regulators 2003, Principle 11). In the Italian context, CONSOB does not provide official preclearance but occasionally publishes public answers to issuers’ application requests on complex accounting matters and undertakes informal dialogues with companies before their annual report’s approval (Strampelli 2015).

18 During the 12 months between the draft decree of the Italian government and final decision by the only official body charged with IFRS interpretation, this operation was lively debated in the Italian parliament, in which opposition parties were highly critical, and in the national and international press, which often accused the Italian government of having deliberately favoured banks through an opportunity constructed ad hoc to improve their results. Despite this widespread public attention, the financial community was partially misled by banks’ 2013 earnings, and only sophisticated users (i.e. financial analysts) clearly spotted this manipulative behaviour.

19 Indeed, BI was the first public institution in charge of the surveillance of the banking sector, but its sphere of authority on banks’ financial statements was reduced by the institution of CONSOB, which was enshrined with supervisory power over the Italian market for financial products. Although BI is in charge of controlling bank risks and ensuring stability, it has tried to assert its territorial claim on the financial information diffused by banks, implicitly seeking to restrict the room left to CONSOB. For instance, after the IAS-IFRS adoption, it seized the opportunity foreseen by law that gives BI and Consob the power to issue specific rules for the financial statements of banks and non-financial companies. Indeed, BI issued Circular 262/2005 specifying binding rules for the layout and preparation of banks’ financial statements and for disclosure to be given in the notes to such statements.

20 Our analysis focused on forty two auditor reports due to ten unavailable reports (see Table 1).

21 The only exception is a Big Four audit firm that never included an emphasis of matter paragraph in its seven audit reports, while all the other audit firms made different choices depending on the client.